Amazon Will Take Your Business

Amazon is ruthless in its strategy to win over new customers. That's why I own shares

Like it or not, the retail landscape is dominated by a few companies. Every year, there's less and less room for mom and pop shops as Wal-Mart(NYSE:WMT) and Amazon.com(NASDAQ:AMZN) snatch up their customers. These giants are ruthless, and Brad Stone outlines just how well Amazon's strategies work in an excerpt from his forthcoming book The Everything Store: Jeff Bezos and the Age of Amazon.

Let me tell you a short storyIn the late 2000s, Amazon wanted to buy Quidsi, owner of diapers.com. Quidsi didn't want to be bought. So Amazon dropped prices on diapers and baby products on its website up to 30%, and slowly but surely revenue growth dried up at Quidsi. Amazon then convinced the owners to sell the company for less than they wanted, and even caused them to miss out on a bigger offer from Wal-Mart.

The end.

Why Amazon can do thisThe owners of Quidsi estimated that Amazon was losing about $100 million on baby products per quarter with its 30% price cut and Amazon Mom offer (one year of free Amazon Prime for new moms). CEO Jeff Bezos rationalized it as the cost of delighting his customers and drawing in more consumers to Amazon's consumables category.

Amazon is playing the game for the long-term, which means keeping customers happy, offering an unparalleled service, and becoming a place where customers can find anything they need at the best price available. The result speaks for itself. Look at the company's revenue growth over the last five years.

The baby product move wasn't just about getting moms to buy diapers from Amazon; that wouldn't be a profitable business plan. It was about getting them to buy everything they need for a growing child from Amazon for years to come (some of which, the company turns a profit on). It was about getting more people hooked on its (profitable) Amazon Prime service. It was about making Amazon the place to shop over its brick-and-mortar competitors.

About those brick-and-mortar competitorsWal-Mart can be just as ruthless as Amazon, and with nearly half a trillion dollars in sales, it has a lot more leverage with suppliers than Amazon. It's able to convince companies to give in to its terms, and that allows Wal-Mart to offer customers low prices on everything it sells.

The most-recent example of this strategy is in its pricing of the new Apple(NASDAQ:AAPL) iPhones. A day after the iPhone 5c and 5s, Wal-Mart announce it would sell the 5c for $79 ($20 off) and the 5s for $189 ($10 off) with a 2-year contract. Wal-Mart recently slashed the price of the 5c down to $45 through the holidays. This flies in the face of traditional Apple pricing, which the company has consistently exercised almost complete control over.

Surely, Apple is still getting its wholesale price from Wal-Mart, but the store's pricing strategy creates an unsavory precedent for Apple products. In the past, Apple has cut off supply to stores that break prices under its recommended minimum advertising price. This prevents any big-box stores from undercutting its own retail stores' price.

Wal-Mart is the No. 1 cell phone seller in the U.S., however, so the option for Apple to cut off its supply is likely off the table. Even without the usual financial incentives Apple kicks in for keeping prices where it wants, Wal-Mart still expects to make a profit on the iPhone, and will likely upsell many customers with high-margin accessories.

The rich get richerBoth Amazon and Wal-Mart are aggressive in their business practices. They're both focused on leveraging scale to make up for thin margins.

Wal-Mart is relatively mature with sales growing at a rate less than 5%. But, at nearly half a trillion dollars in revenue, investors should happily pay $0.50 for every dollar in sales.

Amazon, on the other hand, is still rapidly expanding. Analysts expect sales to continue growing at a rate above 20% for years to come. I don't expect Amazon to stop being a growth play anytime soon, and I don't think Bezos will stop until Amazon is bigger than Wal-Mart. At that point, the company could have the same kind of leverage with suppliers as its brick-and-mortar competitor.

Author

Adam has been writing for The Motley Fool since 2012 covering consumer goods and technology companies. He spends about as much time thinking about Facebook and Twitter's businesses as he does using their products. For some lighthearted stock commentary and occasional St. Louis Cardinal mania Follow @admlvy